Successful planning for life's financial goals is a difficult and, too often, misunderstood process. The effort requires an accurate assessment of an individual's or family's goals and constraints combined with quantitative techniques to forecast the probability of success. Even with an accurate model, the plan will only ultimately succeed if the courses of action prescribed in the plan are followed and the plan is updated and adjusted to account for incorrect assumptions and changes that occur over time.
The financial planning exercise is a matter of allocating resources (e.g., current savings, future savings) to achieve future goals (e.g., retirement age, retirement income). Allocating resources among alternatives, particularly between complex alternatives with multiple aspects and considerations, can be extremely difficult. An investment professional may make the decision seem easier but there are over 600,000 financial advisors with varying experience and expertise and employed in different capacities, such as financial planners, financial consultants, stock brokers, insurance agents, and the like to name a few such titles. While many investors may use an investment professional to assist in planning for their futures, there are millions of investors who are struggling to make these decisions on their own with little or no assistance. Probably the largest group of non-assisted investors is in the 401(k) market where there are now more than 40 million accounts. Besides an individual's personal residence, a 401(k) plan is often the largest investment an individual may have, yet these decisions are often made with little background knowledge and inadequate or overly-complicated tools.
Even when assisted by investment professionals, many investors find the financial planning exercise cumbersome, intrusive, and hard to comprehend. Often, this is due to the static nature of the client discovery process and that little, if any, consideration may be given to quantifying personal considerations and preferences. Very little time is spent understanding how the investor differentiates the value of various goals, resources, and constraints. As such, most of the process and results focus on the validity of the mathematical models used in the planning effort. For example, most financial planning questionnaires start by asking the investor questions like:
When do you want to retire?
How much income do you want during retirement?
How much can you save per year?
Are you a conservative/moderate/aggressive investor?
Based on these inputs, the planning tools calculate a projected future value and/or a probability of success in achieving the stated goals subject to the stated resources, constraints and assumptions.
Rarely does the planning process include an effort to determine how the investor differentiates the value of the various goals, constraints, and resources described in the plan. Without this differentiation, financial planning can be an exhausting, iterative process to find the combination of goals and resources that have the right look or feel to the advisor and/or investor. And, because there is no ability to quantifiably link what's important to the investor to what's suggested by the planning model, many investors are incapable or unwilling to fully implement the plan. A method that combines the ability to assess the probability of achieving the goals with differentiation of the value of the investor's goals, constraints, and resources will allow the investor to determine the optimal combination of required probability and satisfaction with the plan. This optimization process allows the investor to arrive at a single combination of goals, constraints, and resources that achieves both probability and satisfaction objectives.
Often, the financial projection is completed without a separate assessment of investor risk tolerance. Without a risk tolerance assessment, the financial projection may result in a recommendation of investments that exceed the risk level that the investor can withstand when that risk is translated into losses in the investor's portfolio. Risk tolerance assessment is often used to determine the ability of the investor to “stay the course” in light of volatility of the financial markets and the investor's portfolio. The investor's risk tolerance is used to select a suitable investment strategy matching the investor's return and risk profile. Typically, the risk tolerance assessment is a simple, scored questionnaire. Financial projection tools may be separately used to determine the probability of the strategy achieving the investor's long-term goals. In many cases, there is a conflict between the risk level suggested by the risk tolerance assessment and the risk level necessary to achieve the goals described in the plan. While other investor-controlled inputs (e.g., desired retirement age, desired retirement income, savings rate, desired college spending) could be adjusted to improve the probability of success, the risk of the investment strategy is frequently one of the first items adjusted in an effort to enhance probability of achieving investor objectives. This step can lead to the inability of the investor to stick with the long-term plan when losses associated with increased risk are realized.
There is a need for a complementary process to typical financial projection tools using forecasts or Monte Carlo simulation. Such a method or system will determine a target or maximum level of suitable portfolio risk; assess investor preferences and priorities with regard to their financial goals, resources, and constraints; and optimize a financial plan by simultaneously addressing and quantifying the probability of achieving long-term investor objectives along with the satisfaction level of the investor with the level of objectives, resources, and constraints necessary to attain that level of probability.